History is often made by single, very powerful individuals acting on their own mission according to their own calling. Many of these individuals are seemingly immune to the reality around them and try to recreate their own reality – sometimes succeeding to advance the well-being of those around them and beyond, but, usually, they just leave the main stage after creating havoc. I could name names. But only one name is relevant for today’s blog – Wolfgang Schäuble, the former CDU German Minister for Finance. Schäuble resigned that role after the recent German elections and is now being feted by the mainstream press as some sort of visionary who kept the Eurozone together through his disciplined thinking and his resistance to populist ideas that would have broken the discipline imposed on Member States by the European Finance Ministers. History tells us differently. He has overseen a disastrous period in European history where its major step towards political and economic integration in the 1990s has delivered dysfunctional and divergent outcomes for the Member States. Some countries (Greece) has been ruined by the policies he championed while others are in serious trouble. Further, despite him claiming the monetary union has been successful, the fact is that the Eurozone is still together only because the ECB has been effectively violating the no bailout articles of the Treaty of Lisbon via its various quantitative easing programs since May 2010. Should it stayed within the ‘law’ of the union, then several nations would have been forced into insolvency between 2010 and 2012. The problem is that while Schäuble is now gone from the political stage, his disastrous legacy will continue.
He recorded an interview with the Financial Times (October 9, 2017) – Transcript: Wolfgang Schäuble bids farewell to the eurogroup – where he reflected on his contribution to the Eurogroup (Eurozone finance ministers), the central economic policy unit of the European Commission.
It was an incredible interview and confirms the view that Schäuble’s goals were quite different to those who might seek to promote general advancement of well-being.
He was asked what he was “most proud of” as a member of the Eurogroup and replied:
I’m very happy that we succeeded … in making the euro more stable than many would have believed possible … I think that shows that we pursued adequate and successful policies.
But fails to mention that the only reason the Eurozone is still together is that the ECB has been effectively violating the no bailout articles of the Treaty of Lisbon via its various quantitative easing programs since May 2010.
While the ECB claims these operations were just liquidity operations (reserve maintenance) the reality is quite different. They might only be buying government bonds in the secondary market but the impact is the same as if they were just buying the debt in the primary issuance stage.
So “we” didn’t succeed. The continuation of the euro is only down to the central bank breaking the law. Without that breach, it would have been curtains, at least for several of the nations (Italy and Spain to name notable examples).
In reflecting on his “regrets”, he said (among other things):
… And of course the side effect of that during the euro crisis was that the ECB had to play a bigger role in overcoming the crisis than it really wanted to. Mario Draghi always said the ECB can never replace what the member states should do. But as long as the member states don’t do it, the ECB must do what it can, within the framework of its own limited mandate …
Recognition and denial of the previous point. The ECB has effectively become the currency-issuer and the fiscal agent for the eurozone, quite a different role that is specified in its “limited mandate”.
The denial continues – that the ECB has been operating within its “limited mandate”. It has exceeded its role and violated Article 125 of the Lisbon Treaty.
This all comes after Schäuble released a parting, 3-page – Non-paper for paving the way towards a Stability Union – the title being the tell tale.
Schäuble’s ‘non-paper’ (whatever that signal was meant to convey) indicates why Germany will never accept a broad, risk-sharing structure within the Eurozone as has been proposed by the new French President Emmanual Macron.
Schäuble’s vision is ‘business as usual’, with even tougher enforcement at the central level.
Three “core principles” are presented:
(1) We must keep fiscal responsibilities and control together, to avoid moral hazard.
(2) We need better instruments to foster the implementation of structural reforms.
(3) We need credible stabilization functions to deal with global or domestic shocks.
In terms of the first principle, one could have no objection the statement, although I would add that there is a third element beyond ‘responsibility’ and ‘control’ – which is required to ensure that fiscal policy can be both accountable within the parameters of the democracy operating and effectively implemented.
That third element is the currency-issuance capacity.
You cannot have effective fiscal policy if you only have a ‘control’ function operating. You cannot have democratic accountability if the voters cannot change those making the decisions.
Which is why the Eurozone is effectively dysfunctional and relies on the ECB breaking its own rules for its continuance.
A properly functioning federation with democratic accountability has to follow three design principles:
1. Fiscal policy (spending and taxation) should be aligned at the federal level with the currency-issuance (central bank) functions. This means that the ‘federal government’ can ensure that asymmetric spending shocks to the federation (that is, which impact differentially on the ‘regions’ within the federation) can be attenuated with appropriate fiscal transfers.
2. The use of the term ‘federal government’ is pertinent – the fiscal agency has to be the responsibility and under the control of elected politicians rather than unaccountable technocrats.
3. The ‘states’ within the federation can have their own fiscal functions according to their own political agendas but the federal level is responsible for the general well-being of the ‘country’ (the ‘federation’). Some ‘federal-state’ arrangement has to be in place to ensure that the states don’t game the federation but, ultimately, in a crisis, the ‘federal’ government has to stand ready to ensure living standards are broadly comparable across all regions.
Wolfgang Schäuble’s vision is quite different and explains why the Eurozone is never likely to become a functional federation.
His ‘non-paper’ explains that “there is little willingness” among Member States to move towards a federation of the type outlined above (in his words “transfer parts of national sovereignty and control of fiscal rules to the EU level (‘Euro Finance Minister’), together with a greater democratic legitimacy”).
The creation of a European Monetary Fund (EMF), which would just extend the existing European Stability Mechanism, “to provide temporary financial support under strict reform conditionality”.
So a European version of the IMF – keep a government solvent but force it to introduce scorched earth policy choices when it is beset with a negative non-government spending shock.
In other words, entrench the practice of pro-cyclical fiscal policy (cutting public net spending when non-government spending is declining), which is the anathema of sound fiscal practice.
Further, Schäuble writes that:
It is therefore important to expand the ESM’s radar and give it a stronger role in terms of monitoring country risks. The aim is to identify, in cooperation with other institutions, stability risks for and in Eurozone member states more effectively and at an earlier stage than in the past, and to monitor these risks so that they can be reduced by the affected countries themselves. The IMF’s Article IV consultations could serve as a blueprint for this new role.
Such a role for the ESM should also include monitoring compliance with the Member States’ obligations under the Fiscal Compact that was adopted in 2012. The ESM could gradually be given a stronger, neutral role with regard to the monitoring of the Stability and Growth Pact.
In other words, technocrats working within the ESM would be empowered to delve into Member State finances and impose conditionality where it thought the State was likely to (or was) violating the fiscal rules (Fiscal Compact).
Nothing democratic in that.
Nothing engendering responsible fiscal policy, where the aim is to advance well-being rather than adherence to inappropriate and context-free fiscal rules.
Further, the ESM would force defaults onto insolvent Member States and the losses would be pushed onto “private creditors” under a sharing arrangement with the ESM.
The ESM would not be a buttress to Member States struggling to meet the fiscal rules. Schäuble explicitly rejects the idea of creating a ‘federal fiscal capacity’:
More ambitious scenarios and plans for the ESM and its financial capacities, either regarding the possible role as an additional backstop for the controversial European Deposit Insurance Scheme, or regarding a brand new fiscal capacity as a transfer mechanism for the Eurozone would put much too great a strain on the ESM and go against its core purpose of bailing-out countries in severe trouble.
That is, Germany remains firmly opposed to reforms that might render the Eurozone functional and capable of supporting sustained prosperity.
And for the historians among us, Schäuble’s insistence on a ESM watchdog recalls the original German proposal advanced in 1995.
Recall that in November 1995, the then German Finance Minister Theo Waigel circulated a Memorandum in which he proposed a ‘Stability Pact’ to restrict government fiscal policy discretion. The Maastricht Treaty had left the fiscal side of the EMU up in the air.
The Treaty included articles relating to the coordination and monitoring of Member State budgets and the ‘excessive deficit procedure’ but suggested that the detail, which was outlined in the Protocol attached to Article 104, would require further legislation and incorporation into the Treaty.
The genus of Waigel’s ‘Communication’ came after the German Federal Constitutional Court ruling on October 12, 1993, which gave the green light to the German Parliament to approve Germany’s entry into the EMU on the condition that price stability would be a primary objective of the monetary system.
The Court’s decision and the publicity that surrounded the case brought home to the German government the degree of public hostility about the impending EMU membership.
Wegel told the Bundestag on November 7, 1995 that he was “proposing a Stability Pact for Europe as a binding commitment by the participants in the third stage of the EMU”.
He indicated that the ‘Stability Pact’ should limit fiscal deficits to 3 per cent (in unfavourable periods). In normal periods, the deficit should never exceed 1 per cent of GDP, which meant his proposal was even more extreme than the approach than had been floated at Maastricht earlier in the decade.
Wegel pushed his idea to the Ecofin (Eurogroup) Council meeting in Brussels on November 27, 1995. They were concerned because he wanted a harsher regime imposed than outlined in the Treaty of Maastricht and also proposed to work outside of the normal European Commission institutions.
As part of his proposed ‘Stability Pact’, he wanted to secure an intergovernmental agreement to set up the “European Stability Council” which would manage the surveillance and compliance processes of the Pact.
It would impose harsh penalties and other sanctions on nations that breached the rules.
History shows us that France, Spain and Italy resisted Wegel’s plan.
Waigel failed to demonstrate how the rigid rules he wanted enforced could underpin economic growth and low unemployment. He just maintained the mantra that price stability would reduce the transaction costs, which he asserted would encourage investment.
Further, the idea that a nation, facing a major decline in private spending, which had forced its deficit above 3 per cent, would then face a significant fine was idiotic. The penalty would further reduce the ‘offending’ nation’s capacity to provide fiscal support to the economy in bad times and worsen unemployment.
By the end of 1996, Waigel’s ‘Stability Pact’ had become the ‘Stability and Growth Pact’ after a screaming match between French President Chirac and German Chancellor Kohl.
Wegel’s French counterpart told him that “What you are proposing is a computer that takes the decisions. Policy by Software”.
I cover this period in detail in my 2015 book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale.
Schäuble also rejects any suggestion that the current fiscal framework, whereby Member States bear the primary responsibility for spending and taxation but are forced to limit the flexibility to keep within the Fiscal Compact is dysfunctional.
The flexibility in our fiscal rules exists exactly to allow them to work.
Given the main economic indicators have been diverging rather than converging across the Member States since the crisis one wonders what a working outcome is in Schäuble’s view.
With unemployment still above 21 per cent in Greece, around 17 per cent in Spain and high in many other Member States, the system is clearly not working.
There is a clear relationship between the fiscal austerity and the divergent outcomes, which brings into question the ‘flexibility’ of the rules.
Clearly, there is insufficient flexibility for a Member State struggling with a major spending collapse within the rules. The crisis showed that the automatic stabiliser component alone blew the fiscal deficits beyond the allowable limits and invoked the Excessive Deficit Mechanisms (with austerity imposed as a result).
He also wrote that:
… a new fiscal capacity or unemployment insurance is economically not necessary for a stable monetary union. Countercyclical public spending is never in time …
That is categorical.
And this is the standard mainstream line that characters such as Milton Friedman used to disabuse the notion of activist discretionary fiscal policy – the lags are too long and so fiscal policy becomes pro-cyclical – by the time, the government gets its act together, the non-government spending has recovered and so the fiscal stimulus just overheats the economy.
First, the fiscal rules in the Eurozone are largely pro-cyclical anyway as noted above.
Second, the lessons of the crisis is that governments that became pragmatic and rejected the ideological antagonism to deficits found effective ways to spend money and reduce the impact of the collapse in non-government spending.
Third, a program such as the Job Guarantee, would immediately chime in as the non-government sector contracted – people would move very quickly into paid work (which was designed in advance to be operational) rather than, as they do now, move into the unemployment queue.
Finally, Schäuble thinks that Member States suffering “asymmetric shocks” then “better migration within the EU27 could offer a much stronger possibility to keep unemployment … under control in case of crisis.”
It is quite clear that intra-Europe migration is insufficient despite the relaxation in rules (Shengen) to reduce the gross disparity in unemployment rates across Europe.
What other features of the ESM tell us that Schäuble hasn’t worked out that the ‘German-view’ on Europe is dysfunctional.
The idea that the ESM would engage in insolvency procedures immediately tells us that Schäuble has no truck with the Eurozone being a functioning monetary union.
In fact, what he is proposing is redolent of the unworkable pre-Maastricht situation where countries with external deficits were forced to offer higher interest rates to prevent currency depreciation.
The difference now is that the bond markets would force Member States who were struggling with fiscal deficits due to recessed domestic conditions and facing default risk to pay higher yields on any debt issued.
While all Member States face default (credit) risk on the debt they issue because they do not issue their own currency, economies facing recession would face intolerable demands from the bond markets.
The spiral to insolvency would then be accelerated just as the currency crises in the 1970s and 1980s were self-fulfilling because of the insistence of Member State governments in retaining unsustainable fixed parities against the powerful German mark.
In his Financial Times interview, Schäuble said that “The euro should be the currency of the whole EU. We need to reach a point where the whole of the EU uses it.”
However, Schäuble proposal to introduce the ESM would provide a massive disincentive to the remaining European nations to surrender their own currency and join the EMU.
The reliance on bond markets to discipline and ultimately, force governments into insolvency is a recipe for chaos rather than convergence and stability.
It is clear that the German view – if it persists after Schäuble’s departure – maintains the strong line against any notion of debt-mutualisation and risk sharing at the ‘federal’ level.
The ‘non-paper’ is effectively a religious statement rather than having any coherence. It just asserts that things are fine, can be slightly improved with more surveillance, tighter rules and more structural policies (aka wage and pension cuts etc).
The inherent bias towards crisis will only be accelerated if Schäuble’s full suggestions are the way the European Commission moves.
Schäuble leaves a terrible record in my view although the media is holding him out to be a visionary.
That is enough for today!
(c) Copyright 2017 William Mitchell. All Rights Reserved.